Five Predictions For 2020

Look into the crystal ball

2020 Predictions

  1. The Chinese stock market will outperform
  2. Berkshire Hathaway will cut several deals with distressed companies at bargain prices
  3. Top line shines, margins suffer for diversified retailers (grocery)
  4. The Fed will nationalize an additional $5+ trillion of the national debt
  5. Extraordinary government programs to bailout small businesses

 

With large swaths of the global economy shutdown to combat the Coronavirus, the U.S. stock market has experienced one of its quickest declines ever.

The S&P 500 index dropped 32% in a single month (Feb. 19th to March 20, 2020). Small companies—represented by the Russell 2000 index—have dropped even more: declining over 40% from year-to-date highs.

What’s next? What should investors expect as more people are stricken with COVID-19 and both the human and financial impacts ripple through society?

Nobody can know what the future will bring, but I humbly submit the following 5 predictions for the coming year.

 

  1. The Chinese stock market will outperform

Ironically, given the Coronavirus started in China, it is looking like China may suffer less economically than other large countries.

The Shanghai composite is “only” down about 13% year-to-date—less than half that of the U.S. and most other major stock markets.

I believe this trend will continue and Chinese stocks will outperform most other equity markets in 2020.

 

  1. Berkshire Hathaway will cut several deals with distressed companies at bargain prices

Berkshire Hathaway (BRK.A)—run by Warren Buffet—is sitting on over $120 billion in cash and short-term investments (as of year-end 2019). The company has openly been looking for large acquisitions, but as a value investor, recent high valuations have impeded any action.

I expect Berkshire to cut several sweetheart deals over the next few months, as they did during the GFC (notably with Goldman Sachs and Bank of America), as companies become dangerously short of cash. With available cash and a stellar reputation, Mr. Buffet’s company is in the enviable position of being able to buy when others are selling in distress.

Not only does an investment from Berkshire Hathaway provide quick access to cash but provides the all-important vote of confidence from one of the greatest investors of his generation.

 

  1. Top line shines, margins suffer for diversified retailers (grocery)

News reports have highlighted long lines and bare shelves (mainly of toilet paper) at Costco and other stores. Costco, Wal-Mart, Target and other companies selling groceries and other basic household supplies are experiencing a surge in demand for certain items. Likely leading to a meaningful spike in revenue.

Although revenue (i.e., top line) growth should be robust, it is not obvious what the impact will be on their margins and earnings (i.e., the bottom line). Groceries generally have lower margin compared to other products sold; sometimes even sold as loss leaders to generate foot traffic for the sale of higher margin items. But under the current conditions, are people buying those higher margin items when they binge on toilet paper?

In addition, there will be a myriad of extra costs incurred as these companies adjust business practices. Some firms are continuing to pay employees unable to work (e.g., symptomatic or high-risk), have temporarily raised wages, and/or are paying increased overtime for those working long hours.

My hunch is margins will suffer at these firms even if they manage to grow the bottom line.

 

  1. The Federal Reserve of the United States will nationalize an additional $5+ trillion of the national debt

During the Global Financial Crisis (GFC), the Fed launched a series of programs dubbed Quantitative Easing (QE). The purpose of QE was to lower interest rates—by purchasing government debt and mortgage-backed securities—in hopes of stimulating economic growth.

Eventually the Fed purchased almost $4 trillion worth of U.S. government and other debt. Although ostensibly the plan was to sell the acquired bonds once the economy recovered, it took 8 years after the end of the recession before the Fed slowly start decreasing their holdings. Even then, they quickly stopped after only running off about 20% of what they had purchased.

Now the Fed has restarted QE with no limit on how much government debt they will purchase; having already added over one trillion dollars in new debt purchases over the past 6 months or so. Assuming they buy up the same percentage of the national debt as they did during the GFC, it could total more than $5 trillion of our national debt being nationalized (compared to around $2 trillion in government bonds during the GFC).

See How the USA Will Default on the National Debt

 

  1. Extraordinary government programs to bailout small businesses

Around half of all employment in the United States is from small businesses. Because of this, and as a reaction to the bailout of large banks and auto manufacturers during the GFC, Congress is rightly focused on extending loans to small businesses (as well as airlines and other large companies, again).

But will this really help? If you have a small business—like a restaurant—and just lost several months’ worth of revenue, is a traditional loan going to be enough?

I believe, over the course of the year, we will see governments unveil extraordinary programs to prop up and reimburse small businesses for losses incurred because of the large-scale shutdown of economic activity.

These programs may be as simple as forgivable loans, or something less traditional, like agreeing to cover rent payments for several months (i.e., direct grants tied to a specific expense). Politicians will start getting creative in how to best re-energize the economy and small businesses once they can reopen.

 

These predictions should not be considered investment advice. Please consult with your financial advisor about your own specific situation.

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